Some of you might be surprised to see the title! At LetsVenture, right from 2015, we have been running angel investing masterclasses for new investors, to help them better understand the startup asset class, and structure their investment thesis. One of the questions we usually ask our investors is, “Why do you angel invest? Why commit capital into a high-risk asset class?” The typical responses we get are: “I want to be a pseudo entrepreneur”, “I want to work with founders and contribute to their journey”, “I want to stay in touch with the rapidly changing market trends”. Of course, the underlying thesis is also, “I want to make money”.
Many of you will know that investing in private markets is the only way to make non-linear returns and create wealth. However, in the last 2 to 3 years, having watched many marquee & experienced investors place their hat in the ring, there is some dissonance in the way “deals” are being built, structured and parcelled out to the long tail of angel investors, many of whom are new to startup investing.
I do think that as private market investing matures in India, some of these practices will iron themselves out; the push & pull of money and interest is the best lever really for corrective action. Meanwhile, I thought I’d pen some thoughts on the “business” of investing to help new investors better find their way and recognise good standard practices.
Who is a lead investor?
A lead investor is someone who has worked closely with founders to evaluate the startup; he or she is their sounding board and go-to person to sort out all the pangs around early startup life! Sometimes a lead investor takes as much as 2-3 months of working with the founders and the company before he agrees to lead the round and he would typically commit 10-15% of the round the startup is raising. For instance, if the startup is raising an INR 6 cr round, the lead investor would commit at least INR 50-60 lakh. He will also typically take a board seat or an advisory board position because being a ‘lead investor’ also entails working with the founder to scale the business, ensuring they connect to customers and next round investors. This means a lead investor could be spending 4-6 hours per startup per month.
From the investor perspective, the lead investor manages the interests of all other investors who participate in the round and protects their rights in follow-on rounds. He or she must also signal to other investors if the business is in trouble. In essence, you can think of him as the captain of the ship, carrying investors on the rocky sea of private market investments; and for all these efforts he or she is rewarded by “Carry” on exit. Simply put, you can look at carry as a success fee given out only at the time of exit and it can be anywhere between 10 to 15%.
This is a global standard practice and the model works well because the lead investor has skin in the game, spends time and effort into the startup and as a virtue of being a lead, also understands portfolio allocation. A good way for new investors to understand the ropes is to back Lead Investor Syndicates. We have many such syndicates on LetsVenture where information on the lead including his exit history, board positions, portfolio allocation is presented upfront.
Who is an allocation led investor?
This is someone who is typically from the startup ecosystem (CXOs at startups, mature founders themselves, experienced angels) and is well-networked. The Indian investing ecosystem is still super small and within six to twelve months of being active, most investors become known in the founder circuit. Now, depending on the value of the network and brand equity of this investor, he tends to get “access” or “allocation” to deals – in part because having his or her name on the cap table is seen as a rite of passage for founders.
How this positioning is different from a lead is that the role of the investor here is primarily to get an allocation in an existing “deal” (typically a ‘hot startup’ or a ‘VC-led round’). Typically, this marquee investor has NOT evaluated the deal and he is most likely drawing signals from the lead investor who is putting in a large cheque. He will also most probably NOT get a board seat or even an observer position and as such cannot represent investor rights. And really all of this is actually because at the end of the day he is probably committing just 0.5-1% of the round. So, if it is an INR 2 cr allocation, he is putting in just INR 2-3 lakh.
All of this would be okay but for the part when we come to the “carry” levied. This is where the math goes awry because with just a 0.5 – 1% contribution to the round and without all the incumbent responsibilities of a lead investor, this marquee angel still takes up 10-15% carry on exit. This not just eats into the lead investor’s carry but also diminishes the returns for all the investors.
And, this is where I think angel investing is breaking in India. In the rush to invest in “hot deals”, the real narrative has started to become fuzzy. In my mind, the allocation led carry should not be more than 5%. It can be 10% if the investor has a track record of working with founders. Ultimately, that is the reward of the hustle and the social currency an investor had built over time to get preferred access.
Now, if you are a new investor here is a simple checklist to guide you through the math of angel investing. As a new angel who is participating in deals via an online network, you are well within your right to ask questions about the funding round, including how and where the allocation has come from. If you are backing a Lead Syndicate you can still, ask these questions.
About the “Lead Investor”
- Has the investor done due diligence on the startup/founder before investing? Not legal or financial diligence which is done as part of the closure process but business diligence and founder diligence.
- How much is the investor investing or what percentage of the round is he investing?
- Does he have a board seat or an observer position?
- How many deals has he led in a typical year? An investor cannot be possibly be leading 20-25 deals in a year – that would mean 100 hours a month just working with startups. If that’s the case, then he is a full-time lead investor and merits his position and worth!
For an Allocation Led Deal
- Has the investor who has got the allocation done some diligence on the business and the founder?
- Of the allocation received, how much is he personally investing?
- What is the carry he is charging for the allocation?
It is finally your money, your decision. I hope this helps you make better-informed decisions when you commit your next cheque to a Syndicate. Ask questions or read the fine print – it will certainly make discussions at the time of exit more pleasant for all of you.
Here’s a blog on angel investing in downturns!